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Creighton Value Investing Panel (4/29/11)Panelists

Whitney Tilson: T2 Partners2.

Vitaliy Katsenelson: Investment Management Associates3.

Michael Green: Evergreen Capital Management4.

Patrick Brennan: RBO& Co.

Moderators

1. Charles Heider: Moderator Emeritus (served on the Board of Directors at Creighton for 17 years)2. John Manginn: Manginn Associates3. Mark Mowat: Frontier Capital LLC

Question 1- John Manginn: What are the common characteristics of value stocks? Which are mostimportant?Whitney Tilson:

From chapters 8 and 20 of

Ben Graham’s

The Intelligent Investor

, we learn that intrinsicvalue and margin of safety are the most important. The key is to be very patient until you find asituation in which there is a big margin of safety. But, you also want to find something that is trading at amajor discount to intrinsic value.(Addressing other panelists) How do you figure out intrinsic value and what causes a stock to trade at adiscount to that?

Vitaliy Katsenelson:

The first thing to do is analyze a company and this is where the concept of corecompetency comes in. Insurance is not in his core competency. Once you understand a business you canvalue it. It may be best to use all of the valuation techniques if you can. Margin of safety is function of a

firm’s

management, competitive advantage, growth prospects, and dividends. The higher the quality thecompany, the less margin of safety you need. You need less margin of safety with Wal-Mart (WMT) thanyou need for Sears (SHLD). You need less of a margin of safety for a growing company than you do forone that is not growing.

Michael Green:

Agreed with the previous comments. Competency is intangible and very important. If hecannot

understand how a company makes money then he moves on. It doesn’t matter how cheap it is

on valuation metrics, if you

can’t

understand how it makes money you

can’t

understand when it couldbecome undervalued.

Question 2: Michael Mowat- Are there any industries or sectors that lend themselves better to valueinvesting? Has that changed over time?Patrick Brennan:

The name of the game is to trying to predict streams of free cash flow. You wantbusinesses where there is confidence in terms of the yearly free cash flow

. You don’t want to worry

thatthey won

’t make any money at all. You want to have

an idea regarding free cash flow over the next 2years. Technology companies are very tough to predict free cash flow for. It is hard to know whichphone or tablet will take market share so he stays clear of those. He likes companies with nice brandsand that can raise prices. Sometimes financial companies lend themselves to value investing analysisbecause they trade below liquidation value. You are dealing with assumptions in terms of returns, butright now they are seeing opportunities in this space.

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Vitaliy Katsenelson:

A client came to his office with a portfolio that was bought in 1998. A bunch of thestocks were bought when they were trading at 30x-50x earnings. These are the types of companieswhose stocks trade at 9x-10x EPS now. They were overvalued back then and now psychology haschanged. Earnings have doubled or tripled since then

—

Wal-Mart (WMT) and Cisco (CSCO) are goodexamples. People hate these companies if they bought the stocks back then. The companies did whatthey were supposed to do, but the prices were just too high. Portfolio managers

won’t

listen to analystswhen they bring up or pitch these companies. People ask why buy now since they have lost so muchmoney? Stocks go from extremely overvalued to extremely undervalued and large cap, high qualitycompanies that you would put in your mother

’

s account are extremely cheap now.

Question 3: John Manginn-

Buffett biographer Alice Schroeder said she has never seen Buffett use asingle valuation model. Instead, he uses a simple filtration process of handicapping and assessingmanagement. Is there value to modeling?

Whitney Tilson:

It is a good idea for students to learn traditional discounting and valuation models.

Buffet doesn’t have to do this because he has been doing this 24/7

for 50 years. He is doing the models, just without Excel or a calculator. Just like you learn to fly an F-16 after many years

—

it becomes part of your DNA. Investing is an experienced -based business. Becoming a great investor is like becoming agreat surgeon or fighter pilot. You initially learn from someone else and then go out on your own.How do you get up the experience curve as soon as possible? Buffet took everything else out of his lifeto a scary degree, at least according to Alice Schroeder. At one point Whitney pitched a buildingcompany to Buffett. He responded back in one day and Whitney was surprised to learn that Buffett hada great knowledge of the company. He remembered an obscure company from 40 years earlier andnamed a price he would be willing to buy it at today. This is where we are all trying to get to

—

after 50years of practice. This is also why Buffett

doesn’t need a spreadsheet. You first have to l

earn thebasics

—

walk before you can run.

Patrick Brennan:

Discounted cash flow (DCF) analyses do have value. He did a lot of these during hisinvestment banking career. It is really important to make assumptions about revenue growth andmargins because it gets you to ask a lot of crucial questions. Are their political headwinds? What are thenext 10 years going to look like versus the past 10 years? When you do a DCF you have to makeassumptions about certain things that get you thinking about the stock. He understands the limitationsof the model. But, he believes in going through the exercise so that you ask the right questions aboutthe company.

Question 4: Michael Mowat-

How do you gain confidence in your valuation of companies? How do youstay within your circle of competence?

Michael Green:

Said that if he can understand how the company makes money, he can get comfortablewith the valuation metrics. The models used today versus what Buffett has used for years are just tools.You need to know the limitations of your tools. You need to apply your own limitations when usingthose tools. You can crunch numbers all day but if you can

’

t understand how the company makes money,the competitive environment or management decisions, then you can

’

t understand a company. Youneed to be able to explain the company to him like he was a 6 year child. You need a simple story of howa company makes money.He remembers being on conference calls during the tech boom. Analysts were pitching companies thatwere growing revenue but had no profits. They claimed it was a new paradigm and that profits andreturn on equity were no longer important. But fundamentals are always still the basis for equity

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analysis

—

ever since Ben Graham was alive. Modeling techniques are just different ways of looking atthe same thing.

Whitney Tilson:

Said he knows of a company with 80% gross margins and 30% net margins. The stocktrades at 8x EPS

—

net of cash. There is no other company that is statistically so cheap and has such greatfundamentals. Of course he is talking about Microsoft (MSFT). The stock has been a value trap

—

flat overthe last 10 years despite revenue growing 150%. It is one of the best companies in the history of theworld because it generates infinite returns on capital. You will never find a better company.Then why is it so c

heap? He doesn’t think it s

hould be

—that’s why they own it.

But, no spreadsheet cananswer that question or any of the following. Is this a company at the very tail end of its growth story oris it an incredible growth company? Is it going the way of newspapers? Is technology passing it by? Inother words, is MSFT declining? Tilson does not think so. The company is still growing right now becauseof Windows 7 and Office. The consensus view is that it is a lumbering dinosaur being leapt by Apple(AAPL) and salesforce.com (CRM). Betting against the consensus is very hard psychologically. You canlook very dumb for a long time. The crowd is right more often than it is wrong. You have to bet againstthe crowd and be right to make money

. That’s the hard part—

the second one.

Question 5: John Manginn-

Does your circle of competency come in to help avoid value traps?

Whitney Tilson

: The 1

question they ask is whether the company fits in their circle of competence.They look at dozens of companies each week and ask: is this in their circle of competence? Buffet is 80years old and is expanding his circle of competence every year. Some recent examples of new Buffetcompanies include Iscar, BYD, and PetroChina (PTR), and Lubrizol (LZ). He has been buying cyclicalcompanies that he would never have invested in 5-10 years ago. He is actually getting better with age.Your circle of competence does not have to be huge as long as you know its boundaries. But, the widerthe net, the better chance you have of finding hidden gems. Glenn Tongue (his partner at T2 Partners)and Whitney have 40 years of

combined experience but don’t invest

much in biotech or internationalstocks. You have to be humble about it because you can get clobbered when you stray outside yourcircle of competence. In some recent cases they found out that they were the sucker at the poker table.But, it was not their spreadsheets that let them down.

Michael Green:

People fail wh

en they don’t know when to sell a stock. A

stock can do well but people

don’t know

based on their circle of competence what the value truly is. It is easy to lose money that way.

Know what you know and what you don’t know.

Vitaliy Katsenelson:

It is nice to expand your circle of competence but you don

’t

always have to. Inmany cases, you can find great companies outside of the US

—

not in China or Russia. He is talkingdeveloped companies (like some in Europe) where there is a rule of law and democracy. You have toexpand the pond you fish in without taking too much risk or needing to expand your circle of competence. However, you will be taking a new risk

—

currency risk. For example,

HP’s

(HPQ) revenuescome largely from outside the US so you have currency risk there. If you buy a UK company then youhave risk of the pound crashing. You can diversify to mitigate that risk. His advice is to stay in your circleof competence but increase the pond in which you fish.

Patrick Brennan:

When you are looking within your circle of competence you find other opportunities inareas that you do not expect. Right now, very overcapitalized banks are trading at book value or belowbook value and have great loan growth, even without the trouble the big banks have had. Further,Bladex is bank in Panama that he mentioned last year. It has a New York subsidiary so the company is